Marginal Analysis

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Definition of Marginal Analysis:

Marginal analysis is the study of the incremental or next unit. For example, a producer’s marginal cost is the added cost to produce one more unit of a good or service.  

Detailed Explanation:

What is the benefit of purchasing another item? What is the cost to produce one more item? These are decisions made at the margin. Analyzing incremental decisions is marginal analysis. Economists frequently use marginal analysis when evaluating economic decisions and policy. When reaching a decision, it is important to consider only the next decision. Consumers purchase an item only if the benefit gained from the item they are purchase equals or exceeds the cost of purchasing that unit. For example, you may decline to buy dessert after a great meal because the cost is not worth it. The benefit gained is less than the cost.

Marginal analysis also provides insight into how producers reach decisions. For example, it explains why consumers can sometimes get a great deal if they wait until the last minute to take a cruise. Assume the added cost of a passenger is $150. Only those costs directly attributable to the added passenger, such as food and drink. Decisionmakers should not include costs for fuel, wait staff, or stewards since they would be unchanged if another passenger is added at the last minute. Assume the cruise line can sell an additional last-minute ticket for $200. The line would be $50 better off than if they had departed without the passenger. Here, the marginal cost is $150, and the marginal revenue is $200. The cruise line would not sell a ticket for $125 because $125 would not cover the $150 cost directly associated with the added passenger. The bottom line is that vacant airline seats, cruise cabins, or hotel rooms do not generate any revenue. Companies may be willing to offer significant last-minute discounts if they can sell those items at an amount exceeding their marginal cost, or the added cost of that additional customer.

The table below lists many of the terms used in marginal analysis for an incremental decision.

Dig Deeper With These Free Lessons:

Marginal Analysis – How Decisions Are Made
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Fundamental Economic Assumptions
Market Structures Part I – Perfect Competition and Monopoly
Output and Profit Maximization

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